Article originally appeared in FS Advice
The superannuation system is based on the notion that you can build up your nest egg steadily through the course of your working life, but that’s not always the case.
Breaks from the workforce, a lack of disposable funds to top-up compulsory contributions, or just a lack of retirement planning can all lead to retirees finding themselves with a super balance unable to sustain up to four decades of life after work.
This year’s Federal Budget offers two key changes to super that reflect an understanding of this challenge, with the partial removal of the work test for those aged 67-74 and a lowering of the age threshold for those seeking to make a Downsizer Contribution with the proceeds from the sale of the family home.
Together, they make it easier for people immediately before and after retirement to direct larger sums into super, including windfalls from inheritance, property or the sale of a business.
Removing the work test
The more important of the two changes is the removal of the work test for those aged 67-74 making non-concessional contributions, and allowing this group access to the three-year bring forward rule.
Under the present rules, people in this age group are unable to make member contributions to super unless they meet the work test, in which they show they are gainfully employed for at least 40 hours during a consecutive 30-day period in the financial year in which the contributions are made.
That restriction has tended to make it harder for people to direct into super any windfalls they might receive later in life.
This could be the realisation of equity in a family home or sale of a business in combination with other small business CGT concessions.
It could equally be an inheritance, with Australian data showing about a third of inheritances flow to people aged 60 or older, and 63% to those older than 55.
By removing the work test, it becomes possible for the proceeds of a windfall or asset sale to be used to top up super balances, while recognising these contributions are still subject to the $1.6 million transfer balance cap (increasing to $1.7 million from 1 July 2021).
The removal of the work test for this cohort is a good start, although it will likely add to the overall complexity of the system by creating another exception within the system for one age group.
It would have been our preference to see the work test removed in its entirety to reduce the complexity in the system. An aged-based exemption is unnecessary given the contribution cap effectively limits the balance.
Lowering the age threshold for downsizers
The second change expands access to what is known as the Downsizer Contribution by lowering the eligible age threshold. The contribution, first introduced in 2018, allows eligible individuals who sell their main residence to contribute up to $300,000 each to their superannuation.
Previously, the option was only open to people 65 and older but under the Federal Budget proposal, the age threshold would drop to 60, making it an option for many more to consider in the current property market.
Importantly, the downsizer contribution is not counted as a non-concessional contribution and therefore does not count towards contributions caps. It can be made even if your total super balance is greater than the $1.6 million transfer balance cap.
The nature of the Downsizer Contribution throws up some interesting anomalies.
For a start, there is no strict requirement to downsize to be eligible.
If you sell the family home for $600,000, you and your spouse can each contribute up to $300,000 to superannuation (if all other eligibility criteria are met). What you do next is not part of the eligibility criteria, so you could then buy a bigger or more expensive home with other funds available outside superannuation.
This may be particularly relevant for people who are near or at the $1.6 million transfer balance cap and who cannot direct other funds into super. Using these alternative funds to support their next home purchase and making the Downsizer Contribution with proceeds from the family home could be a more attractive strategy.
A second element of the rule is that the property must have been held for at least 10 years and be the main residence of the person claiming the contribution. But here again, there are some important qualifications.
The ATO gives an example of a 70-year-old ‘Ian’ who bought his first house in 2005, lived in it until 2013, then bought a second home, renting out the first.
Although he no longer lives in the first house, the ATO considers him still eligible to make a downsizer contribution on what is now his rental property, noting that “Even though Ian is no longer treating his first home as his main residence, he is effectively exempted from some of the capital gain from the sale of the first home because the property had been treated as his main residence prior to renting it out. He therefore meets the main residence requirement for making a Downsizer Contribution.”
This example opens up the possibility of former-occupiers, now-investors being able to remain in their current property while selling and contributing proceeds of a rental that was their former home.
A third issue to be aware of is the 90-day rule, which requires — for the most part — that the Downsizer Contribution is made within 90 days of receiving the proceeds of sale, which is usually at the date of settlement.
The ATO accepts that sometimes this is not reasonable, particularly in the case of ill health, a death in the family or the need to move house, but there are limits to its preparedness to extend this time.
If the delay is caused by factors outside the contributor’s control, and an application made within that 90-day period, it’s possible a time extension would be granted.
As an example, the ATO suggests an extension would be granted for someone selling their family home and moving into a new retirement village where completion of the new property is delayed. In this case, it takes into consideration that the contributor might be reluctant to commit the sale proceeds to superannuation before knowing the final price of the new property.
But the ATO also outlines a case in which someone too young to qualify for the downsizer contribution seeks an extension of time to allow them to meet the age requirements. In that case, no extension would be granted.
Why do these proposed changes matter?
Despite 30 years of the superannuation guarantee, the balances of most retiring Australians remain low, a key reason half of retirees remain reliant on government pensions.
Only 37% of over-70s held any superannuation, according to ATO figures released in March, and analysed by the Association of Superannuation Funds of Australia.
The statistics, which look at balances for the age group in 2018-19, find nearly 1.7 million older Australians with no superannuation balance at all, while another 350,000 in this cohort held balances under $50,000.